The Indian Government’s Untapped Earning Mantra: Service Tax

In any Welfare State, it is the prime responsibility of the Government to fulfill the increasing developmental needs of the country and its people by way of public expenditure. India, being a developing economy, has been striving to fulfill the obligations of a Welfare State with its limited resources. The Government’s primary sources of revenue are direct and indirect taxes.

Central excise duty on the goods manufactured/produced in India and customs duties on imported goods constitute the two major sources of indirect taxes in India. However, revenue receipts from customs & excise have been declining due to World Trade Commitments and rationalization of commodity duties.

On the other hand, service sector has been growing phenomenally all over the world, though it may vary in degree and magnitude among the various countries. The growing importance of this sector can be gauged from the ever increasing contribution made by the service sector to GDP, thereby pushing back the contribution of traditional contributors like agriculture and manufacturing sectors. India is also not an exception to this changed phenomenon. In 2002, the service sector accounted for 49.2% of GDP while agriculture accounted for 25% and industry 25.8% of GDP. Continued growth in GDP accompanied by higher rate of growth in service sector promises new and wider avenues of taxation to the Government.

In the present day context, services are so widespread and encompass almost all activities like management, banking, insurance, hospitality, administration, communication, entertainment, travel, wholesale distribution, retailing, research and development activities, other professional services, etc. Service sector is now occupying the center stage of the economy so much so that in the contemporary world, development of service sector has become synonymous with the advancement of the economy. Economists believe that with the phenomenal development of the service sector, the exclusion of the service sector from indirect taxation leads not only to the loss of considerable potential revenue, but also creates distortion in the allocation of resources. The distortion arises because the consumer starts making the choice between the consumption of goods and services.

Hence, the Government’s argument was that substantial revenue should come from the service sector and the tax on goods (excise duty) should be complemented with the tax on services. If the tax on services reduces the degree of intensity of taxation on manufacturing and trade without forcing the Government to compromise on the revenue needs, it will enable better pricing of its products by the manufacturing sector in the global market.

With these objectives in mind, service tax was introduced in India in 1994 and today it is envisaged as the tax of the future.

India began its journey of taxation of services on July 1, 1994 with a selective approach for taxation of services. The first year had very modest collections of 407 crores. After appearing largely as just-another-tax for the first 8 years, with collections touching 3,302 crores in 2001-02, service tax took some giant leaps in the next 7 years, both on the back of wider coverage as well as increase in tax rate, reaching 60,941 crores in 2008-09.

Next two years saw the growth somewhat moderating with collections reaching 70,896 crores in 2010-11. The buoyancy began once again on the back of some policy initiatives and Service Tax contributed 97,444 crores during 2011-12, an increase of nearly 37% over the previous year.

While the revenue expectations were often exceeded in all these years the administrative challenge began to assume unmanageable proportions. The newer additions to the list of services often raised issues of overlaps with the previously existing services, confounding both sides as to whether some activities were taxed for the first time or were already covered under an earlier, even if a little less specific head.

There was also a near unanimity across a wide section of thinkers that potential of service tax remained huge and largely untapped. Part of the problem identified was the lack of comprehensive taxation of services, not so much in the lack of coverage but more on account of lack of clarity and significant gaps in existing definitions, exposing the tax collection process to avoidable leakages and litigation.

Budget 2012 has ushered a new system of taxation of services; popularly known as Negative List. The new changes are a paradigm shift from the existing system where only services of specified descriptions are subjected to tax. In the new system all services, except those specified in the negative list, will be subject to taxation.

Hope such changes guide the nation towards a brighter and much more prosperous stage.

The author did his schooling from DPS R.K.Puram. Currently, he is a student member of The Institute of Chartered Accountants of India. He represented his school and received the Gobartimes Award from Mrs. Sheila Dixit. He also secured the School Rank 1 in the International Mathematics Olympiad. He belongs to New Delhi and has a great fondness for the street food as most of the Delhiites, and is addicted to soccer. The best thing he likes about himself is his punctuality. He is extremely attracted to the Indian Bureaucracy and has a great desire to be its part one day.